What is Tax Exemption, Public Charities & Private Foundations

The IRS specifies certain types of organizations that are exempt from federal income tax.  The most common types are charitable, religious and educational organizations, civic associations, labor organizations, business leagues, social clubs, fraternal organizations, and veterans’ organizations.

Although the focus of this page is on organizations exempt under section 501c3, commonly referred to as charities or charitable organizations, I have provided general information about organizations exempt under other Code sections as well.

Obtaining Exempt Status and Who Can Be Tax Exempt?

Not all non-profit organizations are tax-exempt under federal law nor do they qualify to be exempt. To be tax exempt, the organization must be described in section 501(c) and apply for recognition of exemption by filing either Form 1023 for exempt status under 501c3 or Form 1024 for exempt status under another subsection of 501(c). If the IRS approves the application, it will issue a “determination letter” indicating the code section under which the organization is exempt from federal income tax.

Section 501(c) enumerates many different kinds of organizations that qualify for exempt status. Here we explore a brief description of the type of organization that may qualify and the general nature of its activities.

Common Types of Exempt Organizations

Some of the more common types of exempt organizations are defined in the following Code sections:

  • 501c3 Religious, Educational, Charitable
  • 501c4 Civic Leagues, Social Welfare Organizations
  • 501c5 Labor, Agricultural, or Horticultural
  • 501c6 Business Leagues, Chambers of Commerce
  • 501c7 Social and Recreational Clubs
  • 501c8 Fraternal Beneficiary Societies and Associations
  • 501c10 Domestic Fraternal Societies and Associations
  • 501c19 Veterans’ Organizations

Benefits of tax Exemption Status

The main benefit of exempt status is that the organization does not pay federal income tax on income related to its exempt purpose. Other benefits include:

  • Possible exemption from certain employment, state income, sales and property taxes, and
  • Reduced postal rates offered to certain organizations by the U.S. Postal service.

If an organization is not recognized as tax-exempt, it must file one of the following annual income tax returns:

  • Form 1120, S. Corporation Income Tax Return
  • Form 1041, S. Income Tax Return for Estates and Trusts
  • Form 1065, S. Partnership Return of Income

Deductible Contributions to Organizations Exempt Under 501c3

Contributions to 501c3 organizations are deductible on the donor’s federal income tax return if the donor chooses to itemize deductions. Contributions to most other types of tax-exempt organizations do not qualify for a deduction.

501c3 Organizations: Requirements

501c3 organizations comprise the largest category of exempt organizations.  There are two requirements for exemption under section 501c3. The organization must be:

  • Organized, and
  • Operated exclusively for one or more exempt

Requirement 1: Organized

A 501c3 organization must be organized as a nonprofit corporation, trust, or unincorporated association. In addition, its organizing documents (articles of incorporation, trust documents, articles of association, etc.) must:

  • Limit its purpose(s) to those described in section 501c3
  • Align its activities with its exempt purposes
  • Dedicate its assets only to exempt purposes

Requirement 2: Operated

Because a 501c3 organization must engage exclusively in activities that accomplish its exempt purpose(s), other activities are prohibited or restricted.

A 501c3 organization cannot:

Exempt Purpose

An organization must state one or more exempt purposes in its organizing document.  Section 501c3 lists the following exempt purposes:

  • Charitable
  • Educational
  • Religious
  • Scientific
  • Literary
  • Fostering national or international amateur sports competition
  • Preventing cruelty to children or animals
  • Testing for public safety

Typical 501c3 Organizations

The most common types of 501c3 organizations are charitable, educational, or religious.

Charitable Organizations

Charitable organizations conduct activities that promote any of the following purposes:

  • Relief of the poor, the distressed, or the underprivileged
  • Advancement of religion
  • Advancement of education or science
  • Building or maintaining public buildings, monuments, or works
  • Lessening the burdens of government
  • Reducing neighborhood tensions
  • Helping eliminate prejudice and discrimination
  • Defending human and civil rights
  • Combating community deterioration and juvenile delinquency

Educational Organizations

Educational organizations include:

  • Primary or secondary schools, colleges or professional or trade schools that have a regularly scheduled curriculum, faculty, and enrolled body of students
  • Organizations that conduct public discussion groups, forums, panels, lectures, or other similar programs
  • Organizations that present a course of instruction by means of correspondence or through the use of electronic devices, means, or
  • Museums, zoos, planetariums, symphony orchestras, or similar organizations
  • Non-profit day-care centers
  • Youth sports organizations

Religious Organizations

While all churches are religious organizations, not all religious organizations are churches.

Churches:  The term church includes synagogues, temples, mosques and similar types of organizations.  Churches are not required to file an application for exemption.  Nevertheless, many churches do file voluntarily to obtain an IRS determination letter. The letter assures contributors that the church is tax-exempt under section 501c3. To be recognized as a church, an organization must meet certain criteria.  These criteria are outlined in Publication 1828, Tax Guide for Churches and Religious Organizations.

Exempt churches are not required to file an annual Form 990

Other Religious Organizations:  Other religious organizations (e.g., mission organizations, speakers’ organizations, nondenominational ministries, ecumenical organizations and faith-based social services agencies) that do not meet the criteria of a church must apply for tax-exempt status on Form 1023.

Public Charity or Private Foundation

Every organization that qualifies as tax exempt under section 501c3 is classified as either a public charity or a private foundation. Under section 508, every organization is automatically classified as a private foundation, except churches, certain educational organizations and certain trusts, unless it meets the criteria of a public charity listed in section 509(a).

The primary distinction between a public charity and a private foundation lies in the source of financial support. A public charity typically has a broad base of public support whereas a private foundation generally is supported by just a few individuals, such as members of a family.

Whether a 501c3 organization is classified as a public charity or private foundation is important because different tax rules apply to each. For example, the deductibility of contributions to a private foundation is more limited than the deductibility of contributions to a public charity. In addition, private foundations are subject to stricter federal regulation and may be subject to excise taxes not imposed on public charities.

Public Charities

Organizations meeting the definition of public charity under section 509(a) include:

  • Churches
  • Schools
  • Organizations that provide medical or hospital care (including the provision of medical education and, in certain cases, medical research)
  • Organizations that receive a substantial part of their support in the form of contributions from publicly supported organizations, governmental units and/or from the general public
  • Organizations that normally receive not more than one-third of their support from gross investment income and after-tax UBI and more than one-third of their support from gifts, grants, contributions, or membership fees and gross receipts from activities related to their exempt functions
  • Organizations that support one or more of the organizations described above and have a governance relationship with those organizations (supporting organizations)
  • Organizations that are organized and operated exclusively for testing for public safety

To be classified as a public charity solely on the basis of public support, an organization must meet one of the tests set out in the regulations. An organization’s level of public support is calculated on the basis of a 5-year moving average, which includes the current tax year and the 4 years preceding the current year.

Such organizations must continuously seek significant and diversified public support and should carefully monitor their public support calculations to avoid losing their public charity status.

Initial Determination of Public Support Status

A new 501c3 organization will be classified as a public charity for its first 5 years if the organization shows it can reasonably expect to be publicly supported, regardless of the public support actually received during that 5- year period.

The IRS will monitor an organization’s public charity status after the first 5 years based on the public support information reported annually by the organization. Beginning with the organization’s sixth year – and for all following years – if an organization shows it meets a public support test, it will remain a public charity for that year and the next tax year.

Example: Determination of Public Support

If a calendar year organization meets the public support test for the 2021 tax year, the organization is considered to be a public charity for the 2021 and 2022 tax years.  If the organization does not meet the support test for the 2022 tax year, it will still be considered to be a public charity for that year because of the carryover from 2021.

However, if the organization cannot meet the public support test for the 2023 tax year, it will be reclassified as a private foundation starting at the beginning of the 2013 tax year, and should file Form 990-PF, Return of Private Foundation, for the 2023 tax year and for all future years.

Other Common Types of Exempt Organizations

There are many other types of exempt organizations other than 501c3.  However, contributions to these types of organizations are generally not tax-deductible.

 

 

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